Katrina E. White ( 2023 )

United States Tax Court
T.C. Memo. 2023-77KATRINA E. WHITE,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 15886-18. Filed June 21, 2023.
—————
Katrina E. White, pro se.
Frederic J. Fernandez, Allison N. Kruschke, and Mark J. Miller, for
respondent.
MEMORANDUM OPINION
PARIS, Judge: By notice of deficiency dated May 14, 2018,
respondent determined a deficiency of $4,931 in petitioner’s 2016 federal
income tax. The sole issue for decision is whether petitioner is entitled
to exclude cancellation-of-indebtedness income of $14,433 under the
insolvency exception under section 108(a)(1)(B). 1
The parties submitted this case for decision without trial
pursuant to Rule 122.
Background
The following facts are derived from the Stipulation of Facts, the
First Supplemental Stipulation of Facts, and the jointly stipulated
1 Unless otherwise indicated, section references are to the Internal Revenue
Code, Title 26 U.S.C., in effect at all relevant times, and Rule references are to the Tax
Court Rules of Practice and Procedure.
Served 06/21/23
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[*2] Exhibits contained therein. Petitioner resided in Wisconsin when
she timely filed the Petition.
During 2015 petitioner owned and operated Professional Body
Sugaring, LLC, in Menomonee Falls, Wisconsin. On June 17, 2015,
petitioner signed a promissory note to First Bank Financial Centre for
a small business loan of $15,000. Petitioner’s business struggled and
brought in little revenue. Between July 11, 2015, and February 3, 2016,
petitioner made five payments on the loan totaling $661. Following the
February 3 payment, petitioner failed to make any further payments
toward the loan, and on November 23, 2016, the bank charged the loan
off its books. First Bank Financial Centre issued petitioner a Form
1099–C, Cancellation of Debt, reporting discharge of debt totaling
$14,433.
On April 20, 2015, petitioner had entered into a three-year lease
with Leap Properties, LLC, for office space for her business beginning
June 1, 2015, and terminating May 31, 2018. The lease included an
acceleration clause stating that, if rent was late for more than two
months, the full amount on the remaining lease would be immediately
due in full and had to be paid on the third month. Petitioner breached
her lease with Leap Properties, LLC, on January 15, 2016.
In November 2015 petitioner received $8,000 from her family,
purportedly as a loan, to help with her struggling business. Petitioner
did not enter into a written loan agreement or set a repayment schedule,
and the record is unclear as to whether any interest was charged.
Petitioner had made two payments of $100 each toward the loan at the
time her small business loan debt was discharged.
Petitioner timely filed her 2016 Form 1040, U.S. Individual
Income Tax Return. She reported as her only income for the year wage
income of $29,140. She claimed a standard deduction of $9,300 and
exemptions totaling $12,150 for a taxable income of $7,690. Petitioner
did not report the discharge of indebtedness on her return.
Respondent examined petitioner’s return and determined that
the discharge of indebtedness represented gross income to petitioner.
Respondent issued the Notice of Deficiency, and petitioner timely
petitioned this Court for redetermination.
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[*3] Discussion
I. Burden of Proof
In general, the Commissioner’s determination set forth in a notice
of deficiency is presumed correct, and the taxpayer bears the burden of
proving that the determination is in error. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). While the parties submitted this
case for decision under Rule 122, such a submission “does not alter the
burden of proof, or the requirements otherwise applicable with respect
to adducing proof, or the effect of failure of proof.” Rule 122(b).
In cases appealable to the U.S. Court of Appeals for the Seventh
Circuit, as this one is barring a written stipulation to the contrary, see
§ 7482(b)(1)(A), (2), a taxpayer may rebut the presumption of
correctness by demonstrating that an assessment is arbitrary and
excessive or lacks a rational foundation, Pittman v. Commissioner, 100
F.3d 1308, 1313 (7th Cir. 1996), aff’g T.C. Memo. 1995-243. In cases
involving unreported income, such as the present case, this showing is
typically made “when the Commissioner makes no evidentiary showing
at all but simply rests on the presumption or when the Commissioner’s
evidence completely fails to link the taxpayer to alleged unreported
income.” Id.II. Discharge of Indebtedness Income and Insolvency Exception
A. Legal Principles
Section 61(a) defines gross income as “all income from whatever
source derived” including income from discharge of indebtedness.
§ 61(a)(12). Section 108(a) provides certain exceptions under which
discharge-of-indebtedness income is excluded from income. One such
exception arises where the taxpayer is insolvent immediately before the
discharge. § 108(a)(1)(B). Insolvent means that the taxpayer’s liabilities
exceed the fair market value of her assets. § 108(d)(3). The amount of
the exclusion is limited to the amount by which the taxpayer is
insolvent, i.e., the amount by which the taxpayer’s liabilities exceed the
fair market value of her assets. § 108(a)(3), (d)(3); see also McAllister v.
Commissioner, T.C. Memo. 2013-96, at *7 (“The amount by which the
taxpayer is insolvent is defined as the excess of the taxpayer’s liabilities
over the fair market value of the taxpayer’s assets.”).
A taxpayer claiming the benefit of the insolvency exception must
prove (1) with respect to any obligation claimed to be a liability, that, as
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[*4] of the calculation date, it is more probable than not that she will be
called upon to pay that obligation in the amount claimed and (2) that
the total liabilities so proved exceed the fair market value of her assets.
Merkel v. Commissioner, 109 T.C. 463, 484 (1997), aff’d, 192 F.3d 844(9th Cir. 1999).
B. Analysis
Petitioner does not dispute that the loan was discharged in 2016. 2
Rather, she argues that the discharge of the debt should be excluded
from income because she was insolvent at the time of discharge.
Petitioner provided respondent and the Court with an insolvency
worksheet that petitioner alleges shows her assets and liabilities at the
time of the discharge of indebtedness, as well as supporting
documentation of the listed items. Petitioner lists her assets and
liabilities as follows:
Assets Value
Real Property $28,500.00
Cars and Vehicles 1,000.00
Household Goods 559.89
Clothing 2,000.00
Total 32,059.89
2 Petitioner maintains that she did not receive the Form 1099–C and was not
aware that the debt had been discharged until she was contacted by respondent’s
revenue agent. “The moment it becomes clear that a debt will never have to be paid,
such debt must be viewed as having been discharged.” Cozzi v. Commissioner, 88 T.C.
435, 445 (1987). “The nonreceipt of a Form 1099 does not convert taxable income into
nontaxable income.” Rinehart v. Commissioner, T.C. Memo. 2002-71, 2002 WL 459098,
at *2.
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[*5] Liabilities Amount
Student Loans $5,293.65
Accrued or Past Due 961.31
Residential Utilities (water)
2,500.00
(estimated WE Energies)
Judgments 3 8,128.33
Business Debts 14,433.00
(small business loan)
21,700.00
(lease breach)
Other liabilities 7,800.00
(family loan)
1,119.78
(furniture bill)
Total 61,936.07
Respondent argues that petitioner has not adequately
substantiated that the family loan, the lease breach acceleration debt,
or the estimated WE Energies bills were bona fide debts. Under
respondent’s calculation, petitioner’s liabilities at the time of discharge
totaled $29,936.07 against assets totaling $32,059.89. According to
respondent, then, petitioner was solvent by $2,123.82 and the
cancellation of petitioner’s loan constitutes gross income.
With respect to the lease breach acceleration debt, respondent
argues that petitioner has failed to demonstrate that the debt was a
bona fide debt. Specifically, respondent contends that, because Leap
Properties, LLC, did not sue or otherwise take action to collect the
amount due on the lease and because petitioner did not make any
3 In support of this amount, petitioner introduced copies of judgments, credit
reports, and other documentation. These documents indicate that petitioner has also
been known as Katrina Duckworth or Katrina Gray.
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[*6] payments toward the amount due, petitioner has failed to show that
the debt was a bona fide debt.
The Court disagrees. Petitioner provided a copy of the lease
agreement, as well as a letter from Leap Properties, LLC, stating that
petitioner breached the lease on January 15, 2016. The terms of the
agreement creating the obligation to pay generally determine whether
and in what amount the taxpayer will be called upon to pay. Merkel, 109
T.C. at 476 n.10. Under the terms of the lease, the entire amount
remaining on the lease would become immediately due. The lease
agreement between petitioner and Leap Properties, LLC, was an arm’s-
length transaction for a multiyear lease on commercial real estate, and
the obligation to pay was legally enforceable at the time the $14,433
small business loan debt was discharged. Nothing in the record suggests
otherwise. The fact that Leap Properties, LLC, did not sue petitioner to
collect the debt does not in and of itself mean, as respondent suggests,
that it was not a bona fide debt. Respondent cites no authority for the
requirement that, for the Court to determine insolvency under section
108(a)(1)(B), a creditor must bring legal action or the taxpayer’s
liabilities must be brought to judgment, and the Court is aware of none.
Taking into account the $21,700 liability for breach of the lease,
petitioner’s liabilities totaled $51,636.07, 4 while the value of her assets
totaled $32,059.89. Petitioner’s liabilities exceeded the value of her
assets by $19,576.18. Accordingly, petitioner was insolvent at the time
the small business loan was discharged, and the discharge-of-
indebtedness income is excluded.
III. Conclusion
For the foregoing reasons, the discharge of petitioner’s
indebtedness of $14,433 is excluded from gross income under section
108(a)(1)(B). The Court has considered all of the arguments made by the
parties, and to the extent they are not addressed herein, they are
considered moot, irrelevant, or otherwise without merit.
4 This amount excludes the value of the alleged family loan and estimated WE
Energies bills. Because petitioner meets the standard for insolvency with the inclusion
of the liability for breach of lease, the Court does not consider respondent’s arguments
with respect to those items.
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[*7] To reflect the foregoing,
Decision will be entered for petitioner.